1/13/2010 @ 9:44AM

Stock Picking Isn't Enough

“Learn all you can from the mistakes of others. You won’t have time to make them all yourself.”–Alfred Sheinwold

“Freddy” Sheinwold was born in London, immigrated to the U.S. and became one of America’s most famous bridge players. He was also a writer and, at one point during World War II, the chief code and cipher expert for the U.S. government.

Freddy learned that there is a lot to learn in terms of the “what not to dos” in both games and war. I have a great deal of respect for this approach to investing. That’s really what managing risk from a global macro perspective is all about.

Take, for instance, what’s happened to consensus expectations on Chinese growth and stock market returns in the last 24 hours. This is how Bloomberg News summarized why Chinese stocks got hammered overnight: “An unexpected shift by China’s central bank to restrain lending may foreshadow higher interest rates and a relaxation in the nation’s currency peg against the dollar.”

Obviously, those of you who have been going through your global macro paces for the last six weeks know that these proactive moves by the Chinese government are not “unexpected” at all. All you needed to have was a repeatable (daily) global macro process and you would have already positioned yourself for this. China explicitly told us they were going to tighten the screws on speculative investment. Making that call wasn’t rocket science.

Rocket science is what some investors consider their super-special views on bottoms-up investing. Sorry to break it to you, Captain Stock Picker, but figuring out that a company is cheap with pending positive investment catalysts is something that all great investors should be able to do. If it was a God-given talent set aside for a select few, why do we have so many money managers in this world purporting it to be their secret sauce?

I believe that you need to wake up every morning with an all-star bottoms-up investing process and a disciplined, but malleable, top-down global macro risk management process to augment it.

Having been an “I know everything about this company” hedge fund Jedi of doing one-on-ones (I did over 256 of them in 2004) with corporate management teams, I have the perspective to tell you this because I have made plenty of mistakes. At least two-thirds of my company-specific investment blowups have been due to missing Mr. Macro Market moves. That’s why I wake up early every morning trying to stay one step ahead of the macro mistakes of others.

China closed down 3.1% last night, taking the Shanghai Composite below its immediate-term trade line of 3,220. The Chinese have raised rates twice in the last two weeks and have now explicitly tightened the reserve requirements on their domestic backs to much higher levels than what you currently see here in the U.S. banking system. China wants “quality” growth, not speculative levered-up growth.

On the heels of the unprepared reacting to the “unexpected,” the Hang Seng Index in Hong Kong broke its critical intermediate-term trend line of 21,829, closing down 2.6% on accelerating daily trading volume. Korea, Japan and Indonesia saw their stock markets down in reaction to the wall of China worry, trading down 1.6%, 1.3% and 1%, respectively.

The new reality remains. Mr. Macro Market waits for no one. Global markets are increasingly interconnected and demand that money managers learn from the mistakes implied by consensus not having a global risk management process.

Another major global macro risk that continues to weigh on my mind is sovereign debt. I touched on this Tuesday, so here’s the update. Indonesia tried to plug the market with $4 billion in debt yesterday, and the demand was only there to get half of that done. So the government issued $2 billion in 10-year sovereign notes at 6%. That’s 225 basis points higher than what He Who Sees No Inflation (Ben Bernanke) is willing to issue prospective U.S. Treasury investors on the same duration.

What a deal, right? Since the beginning of 2010 we have now seen the Philippines, Mexico, Poland, Turkey and Indonesia issue $10.9 billion in debt. To put that in context, that’s the highest level of debt issuance for emerging markets since the tech bubble days of 1999. Again, I don’t think we have massive equity market bubbles in the world like we did in 2007, but we definitely have a debtor nation bubble.

As our mentor Herb Brooks beats into our thick hockey skulls: Again! Learn from other people’s mistakes. Nations piling debt upon sovereign debt is not new, folks. Neither is
Moody’s
giving a country like Japan an absurd debt rating of Aa2 (their third-highest rating, whatever that is) when it has pushed their debt balance over 200% of GDP. Players and pundits alike are constantly making macro mistakes in this game. Use that consensus backboard to your advantage.

My immediate-term support and resistance lines for the S&P 500 are now 1,118 and 1,153, respectively. We were a buyer on weakness in U.S. equities Tuesday. We covered our short position in gold on the biggest down day it’s had in three weeks. We remain out of China (and all emerging markets other than Brazil) for now.